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Behavioural​ equilibrium real exchange rates and misalignments: Evidence from large emerging markets

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  • Banerjee, Krittika
  • Goyal, Ashima
Abstract
In order to contribute to the debate on whether exchange rate under-valuation was a major factor in global trade imbalances that culminated in the 2008 Global Financial Crisis (GFC), we estimate long-run equilibrium real exchange rates (ERER) for a panel of eight large emerging market economies (EMEs) over 1995–2017 based on structural factors. These include EME-AE (advanced economy) differentials in productivity, dependency and financial development, along with factors like trade openness, sectoral relative price and fiscal procyclicality. Amongst the dominant factors, we find that rising relative productivity appreciates ERER, but is offset by an almost equal depreciation from financial development. Estimated misalignments show both EME under- and over-valuation before the GFC, with under-valuation more prominent in Russia and Turkey. China, India, Indonesia and Mexico were experiencing a correction towards equilibrium from over-valued rates a year or two before the GFC. Post-GFC appreciation in EME ERERs compared to pre-GFC years indicates convergence in EME-AE prices, but misalignments were more in the zone of under-valuation during the period. The absence of substantial under-valuation in pre-GFC years indicates that EME RER misalignments were not a major cause of the GFC. Impulse responses show the limited impact of misalignments on current account imbalances, suggesting that the incentive to devalue was low.

Suggested Citation

  • Banerjee, Krittika & Goyal, Ashima, 2021. "Behavioural​ equilibrium real exchange rates and misalignments: Evidence from large emerging markets," Economic Analysis and Policy, Elsevier, vol. 70(C), pages 414-436.
    • Handle: RePEc:eee:ecanpo:v:70:y:2021:i:c:p:414-436
    DOI: 10.1016/j.eap.2021.03.004
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    1. Mohammad Hassanzadeh & Shahla Mousavi, 2023. "Real effective exchange rate misalignment and currency crisis in Iran," Future Business Journal, Springer, vol. 9(1), pages 1-8, December.
    2. Iqbal, Javed & Mahmood, Fatima & Nosheen, Misbah & Wohar, Mark, 2023. "The asymmetric impact of exchange rate misalignment on economic growth of India: An application of Hodrick–Prescott filter technique," Economic Analysis and Policy, Elsevier, vol. 77(C), pages 809-823.
    3. Ghosh, Saurabh & Nath, Siddhartha & Srivastava, Sauhard, 2021. "Productivity and Real Exchange Rates for India: Does Balassa-Samuelson Effect Explain?," MPRA Paper 110913, University Library of Munich, Germany.

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    More about this item

    Keywords

    Misalignment; Behavioural equilibrium real exchange rate; Panel cointegration; Global imbalances; Under-valuation;
    All these keywords.

    JEL classification:

    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O5 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies

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